An early default clause in a mortgage loan sales agreement may require a savings association to hold capital for loans sold to a third party as if the loans were still carried on the savings association’s books, according to recently issued OTS guidance. In a memorandum to chief executive officers dated April 16, the OTS reminds savings associations that its risk-based capital regulations define recourse as a savings association’s retention of credit risk, directly or indirectly associated with assets sold, that exceeds a pro rata share of that savings association’s claim on the assets. Where there is recourse, a savings association must hold capital for the assets as if they were still held by the savings association. The memorandum notes that mortgage loan sales agreements often contain representations and warranties that meet the recourse definition, and that other provisions that confer some credit risk on the selling institution may be excluded from the definition of recourse depending upon the time period during which the savings association is at risk. The OTS guidance includes examples and diagrams of relevant timelines to illustrate the appropriate capital treatment based on the types of early default clauses contained in the mortgage loan sales agreement.

Nutter Notes: According to the OTS guidance, there is a functional exemption from the definition of recourse for certain early default provisions under the OTS’s risk-based capital regulations. An early default clause or similar warranty (such as a premium refund clause) that, for a period of not more than 120 days from the date of the sale of a mortgage loan, permits the purchaser to require the seller to repurchase the loan if the borrower defaults during that period is not in and of itself considered recourse. However, if the early default clause is actually triggered so that a loan may be returned to the savings association, then the savings association must hold risk-based capital in anticipation of the return of the loan upon notice of the triggering event, according to the guidance. If an early default clause extends beyond 120 days, the savings association must hold risk-based capital from the date of transfer of the loans until the savings association can determine that the warranty period has expired and no sold loans have defaulted. The memorandum also explains that, if a savings association is unable to track which loans it might be required to repurchase, it must hold capital against all sold loans until such time as it can make a determination about potential exposure (i.e., through the period covered by the early default provision).

The U.S. Government Accountability Office (GAO) has issued a report recommending that Congress amend the Federal Deposit Insurance Act (FDI Act) to achieve greater transparency and accountability when the FDIC takes emergency actions under the systemic risk exception. The GAO report delivered to Congress on April 15 also recommends that regulatory reform legislation should ensure greater regulatory oversight of systemically important institutions to mitigate the effects of weakened market discipline from use of the systemic risk exception. According to the report, the FDIC, Treasury and the Federal Reserve collaborated before announcing five potential emergency actions under the systemic risk exception. In each case, the FDIC and the Federal Reserve recommended the emergency actions to Treasury, but Treasury made a determination that allowed the FDIC to proceed with emergency assistance in only three of the five cases. The GAO found that these actions could have affected markets by increasing confidence in financial institutions with an expectation of imminent government assistance, while similarly generating negative effects such as moral hazard.

Nutter Notes: Under the FDI Act’s systemic risk exception, the FDIC can provide certain types of emergency assistance to depository institutions at risk of failure if the Secretary of the Treasury, in consultation with the President and with the written recommendation of the Federal Reserve, determines that compliance with the least-cost resolution requirements of the FDI Act would result in serious adverse effects on economic conditions or financial stability and that emergency assistance could mitigate those systemic effects. Treasury’s determination exempts the FDIC from the least-cost resolution rule, which otherwise requires the FDIC to use the least costly method when assisting an insured institution and prohibits FDIC from increasing losses to the Deposit Insurance Fund by protecting creditors and uninsured depositors of an insured institution. The GAO report points out that the recent applications of the systemic risk exception raise questions about whether the exception may be invoked based only on the problems of a particular institution or on problems of the banking industry as a whole, and whether and under what circumstances assistance can be provided to healthy institutions. The report expressed concern that the agencies’ use of the systemic risk exception may weaken market participants’ incentives to properly manage risk if they come to expect similar emergency actions in the future. The GAO recommended that Congress amend the FDI Act to clarify the statutory requirements and forms of assistance authorized under the systemic risk exception.

Proposed amendments to Securities and Exchange Commission rules that govern asset-backed securities (ABS) would require sponsors of ABS to retain a specified amount of each tranche of the securitization, net of the sponsor’s hedging (also known as “risk retention” or “skin-in-the-game”) to better align the interests of issuers with those of investors. The term “sponsor” in the proposed amendments announced on April 7 means the institution that organizes and initiates an ABS transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the entity that issues the ABS to investors. The SEC’s proposed amendments would also revise the disclosure, reporting and offering process for ABS to provide investors with more detailed and current information about the asset pool underlying the ABS and more time to make their investment decisions. The new rules would require disclosure of specified data relating to the terms of the underlying assets including obligor characteristics and underwriting criteria for each asset in the asset pool. The data would be provided in a standardized electronic format, and issuers would be required to provide the asset-level data at the time of the offering, whenever new assets are added to the pool underlying the ABS, and on an ongoing basis. Public comments on the proposed amendments are due within 90 days after publication in the Federal Register, which is expected shortly.

Nutter Notes: The SEC’s proposed ABS reporting requirements would impose new reporting burdens on originating lenders and the institutions that service the assets in the pools underlying the ABS. As indicated, the proposal would require the disclosure of data for each loan in the asset pool both at the time of the offering and on an ongoing basis. The loan-level data would cover items such as loan terms and underwriting, credit information about the borrower, and characteristics of the property securing the loan. Under the proposed amendments, an identifying number would be assigned to each loan in the pool to track its performance. The issuer may also be required to disclose whether the loan was made without following the stated loan underwriting standards described in the ABS prospectus, the extent to which each obligor’s income was verified (e.g., whether the lender reviewed W-2 forms or tax returns), and detailed information about the steps being taken by the servicer to limit losses on loans that are not being paid in full. The proposal requiring loan-level information would apply to issuers that offer ABS backed by residential mortgages, commercial mortgages, automobile loans and leases, equipment loans and leases, student loans, floorplan financings, corporate debt, and ABS backed by other ABS. Because ABS that are backed by credit card receivables may have millions of accounts in the pool, those offerings would be exempt from loan-level information requirements, but would be subject to more granular disclosure requirements regarding the underlying credit card accounts in standardized groupings.

4. National Banks and Savings Associations Get More Guidance on the Overdraft Opt-In Rule

The OCC has issued additional guidance to national banks on implementation of the November 2009 final rule establishing new opt-in requirements for overdraft protection programs under the Federal Reserve’s Regulation E, and the OTS has proposed similar supplemental guidance. OCC Bulletin 2010-15 released on April 15 also supplements the Joint Guidance on Overdraft Protection Programs adopted by the federal banking agencies in February 2005. The bulletin reviews the conditions that must be met to comply with the notice and opt-in requirements before a bank may assess fees for paying ATM or one-time debit card transactions pursuant to an overdraft protection program, and describes the content requirements for such notices under the final rule. The bulletin also reminds national banks that any marketing or supplementary materials associated with the opt-in procedures or overdraft protection programs generally (which must be set forth in a separate document) must comply with Federal Trade Commission Act (FTC Act) standards; specifically, that marketing must not be unfair or deceptive to consumers, and should provide consumers with timely, clear, accurate, and balanced information that will promote informed decision making.

Nutter Notes: The guidance proposed on April 26 by the OTS supplements the 2005 Joint Guidance on Overdraft Protection Programs, and clarifies the OTS’s supervisory expectations and the application of relevant laws and regulations to overdraft protection programs, including the new opt-in rule. In addition to updating the OTS’s best practices guidance for overdraft protection programs, the proposal also provides examples of specific overdraft practices that the OTS believes constitute violations of the prohibition against deceptive practices under Section 5 of the FTC Act. The final overdraft protection rule generally prohibits financial institutions from assessing fees for paying ATM and one-time debit card transactions that overdraw consumer accounts unless the consumer affirmatively consents, or opts in, to the overdraft protection program. The final rule became effective on January 19, 2010 but compliance does not become mandatory until July 1, 2010. For accounts opened before July 1, 2010, institutions may not assess any overdraft fee on or after August 15, 2010, if the consumer has not opted in. For accounts opened on or after July 1, 2010, financial institutions may not assess any overdraft fee unless and until the consumer has opted in. Comment on the OTS’s proposed supplemental guidance will be due 60 days after it is published in the Federal Register, which is expected shortly.

5. Other Developments: Privacy Notices and Massachusetts Truth in Lending

Federal Regulators Make Privacy Notice Form Builder Tool Available Online

Eight federal regulators, including the federal banking agencies, released the Online Form Builder on April 15 that financial institutions can download and use to develop and print customized versions of a model consumer privacy notice. The Online Form Builder is based on the model form regulation published on December 1, 2009 under the Gramm-Leach-Bliley Act.

Nutter Notes: Institutions that follow the instructions in the model form regulation when using the Online Form Builder will obtain a privacy notice that satisfies the Gramm-Leach-Bliley Act’s disclosure requirements and provides a legal safe harbor for compliance, according to the regulators. The Online Form Builder is available at: http://www.federalreserve.gov/bankinforeg/privacy_notice_instructions.pdf.

Division of Banks Updates Truth in Lending Rules

The Division of Banks has released its final amendments to the Massachusetts Truth in Lending regulations to achieve consistency with recent changes to the federal Truth in Lending rules, the Federal Reserve’s Regulation Z. The amendments are required for Massachusetts to maintain its exemption from the federal Truth in Lending Act and Regulation Z.

Nutter Notes: The amendments include changes to credit card account disclosure and billing practices and other terms mandated by the Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009, addressing electronic delivery of consumer disclosures, changes to account disclosures and prohibited practices in high cost home mortgage loans.

Nutter Bank Report

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